Credit default swaps is a contract in which the buyer makes a series of payments to the seller in exchange for the right to payoff if there is a default in respect of the reference party. The market for credit derivatives became larger than the underlying assets themselves, and it is often alleged that these instruments catalyzed the meltdown. The term paper aims at exploring the instrumentality of these instruments in precipitating the current financial crisis.

After an interesting analysis of what these financial instruments actually are and how they were used, we concluded:

Although the jury is still out on whether credit derivatives catalyzed the financial meltdown, evidence so far seems to suggest that they could indeed have played a crucial role. However, they may not deserve all the vilification that was heaped on them – from “financial WMDs” as Mr. Warren Buffet called them, to disowning of them by their former cheerleader Mr. Alan Greenspan. The genuine benefits of derivatives such as ability to hedge and price discovery of credit risk may in fact be fine-tuned in the future. However, it looks imperative that derivates be brought under the ambit of a regulator and probably a standardized and exchange traded form introduced to eliminate counterparty risk.

If you are interested in this topic, you can read our report by clicking the following link - role of Credit Default Swaps in precipitating the the current financial crisis.